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MENDING EGYPT'S DAMAGED ECONOMY

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Pressure is building on Egypt’s new president, Abdel Fattah al-Sisi, to deliver economic gains.

Spending precious political capital in a race against time to save Egypt’s battered economy, president Abdel Fattah al-Sisi reduced costly energy subsidies and introduced new taxes, in bold, early moves to restore fiscal stability, following his June election. Much more needs to be done to get the economy back on its feet. Al-Sisi is counting on the country’s military-industrial complex and international donors, as well as the Egyptian people, to work with him to restore economic health, but a rapid return to pre-2011 growth levels appears unlikely.

The economy has been badly damaged by years of political unrest, including two revolutions. The weakness of growth over the past three years has been almost entirely the result of falling investment and a sharp drop in tourist arrivals, says William Jackson, emerging markets economist at Capital Economics in London. Tourists are likely to return only gradually, and meantime increasing terrorism in the Sinai by Islamic militants is raising security concerns at Egypt’s Red Sea resorts, he notes.

INVESTORS WARY

Sabra, Eurasia Group: If economic reforms yield positive results, Sisi will have more leeway to deal with increasing challenges in the longer term.

Foreign investors are still wary, Jackson says, and further reforms are needed to improve the business environment. “Egypt’s fast-growing population of 85 million represents a large consumer market, but the impediments to investment are equally large.” Egypt has one of the lowest scores in the region for ease of doing business, and its education system ranks among the worst in the world.

According to Jackson, the Egyptian central bank’s surprise decision in July to raise interest rates by a full percentage point appears to have been made in anticipation of a sharp rise in inflation over the coming months, following the government’s decision to raise energy prices. The government may ask the International Monetary Fund to give its stamp of approval to a reform package in order to unlock billions of dollars of official aid, although Egypt may not necessarily seek an IMF loan, he says.

Hani Sabra, director for Middle East research at geopolitical risk consultancy Eurasia Group, says: “Sisi decided to cut energy subsidies at a time when he was the most powerful and popular. I don’t think he will cut wages or further reduce food subsidies. However, it will take several more rounds of reforms before the economy is on a sustainable path.”

SEEKING STABILITY

A Saudi-, Kuwait- and UAE-sponsored donors’ conference intended to raise funding for the beleaguered country is scheduled for late this year. It will determine the level of future reforms, Sabra says. “The majority of the Egyptian people absolutely want political stability, and Sisi will deliver,” he adds. “If economic reforms yield positive results, Sisi will have more leeway to deal with increasing challenges in the longer term.”

He faces a difficult task in improving the business environment and creating new legal protection for investors, Sabra adds. “Trying to reform the judiciary is risky.”

Jan Dehn, head of research at Ashmore Group, an investment manager that specializes in emerging markets, says: “The measures taken so far are in the right direction. Sisi will have to continue with these adjustments, but he will have to move gradually, so as not to worsen inflation and create a negative spiral. But he has to act now, while he has the support of the people. It is a real balancing act.”

Positive economic growth is absolutely critical in light of Egypt’s high unemployment, Dehn says. Supply-side reforms could increase productivity and investment, but that won’t happen quickly, he adds.

Dehn, Ashmore Group: He has to act now, while he has the support of the people. It is a real balancing act.

Fitch Ratings says financial assistance from Arab Gulf countries will narrow the government deficit, but as a percentage of GDP the deficit nonetheless remains among the highest of all Fitch-rated sovereigns. Shortages of foreign exchange and electricity, fiscal consolidation, and the crowding out of private-sector borrowers will hamper an economic revival, Fitch says. It expects GDP growth to reach 4% by 2016 but says this is well below the level that would absorb new labor-force entrants.

“Sisi is backed by the powerful military, which has restored and is expected to maintain relative political stability,” Fitch says. “Nevertheless, significant sections of the population are disaffected, some parts of the country are affected by sporadic violence, and sequencing adequate economic reforms while preserving social stability will be challenging.”

Egypt’s economic performance is much weaker than it was before the Arab Spring uprisings in 2011, Fitch says. “Growth is significantly lower, unemployment is higher, and inflation is still around double digits,” it says. By 2015, growth and price stability are still expected to lag Egypt’s peers, Fitch says. A modest strengthening of GDP expansion will be insufficient to prevent a further rise in unemployment, it adds.

According to al-Sisi himself, investments in infrastructure are a key building block to growth and stability. He says: “Large-scale, state-run projects will modernize the economy, increase employment and provide vital infrastructure and services.” Nearly all of these projects will be carried out by the military, which has regained control of the $8.6 billion Suez Canal Development Project.

The showpiece of Sisi’s grandiose plans is a development corridor west of the Nile that is to include an eight-lane highway and rail line. Farouk El-Baz, a geologist, has proposed the idea to various Egyptian administrations since 1985. Al-Sisi has embellished the $140 billion project to include 48 new cities. He says it will be funded in part by Egyptians living abroad.

Economists say Egypt’s already heavy debt load will preclude such massive undertakings. They say al-Sisi should focus instead on righting the economy and building more schools and healthcare facilities. How successful his projects turn out, and whether they have the desired outcome, remains to be seen.

FOREIGN INVESTORS REMAIN CAUTIOUS

Recognizing the critical need for foreign direct investment, Egypt has created a separate Investment ministry to focus on attracting new FDI. Ashraf Salman, the new minister of Investment, is the US-educated CEO of Cairo Financial Holding. He is a former head of corporate finance and investment banking at Arab African International Bank. Salman says he is aiming for $10 billion of FDI in the current fiscal year and $14 billion annually in three years.

Portfolio investors have remained engaged in Egypt, says Jan Dehn, head of research at Ashmore Group, but FDI is a more illiquid commitment. “Direct investors would look for more macroeconomic stability to be achieved and political stability maintained. Western governments appear to be more comfortable with a ruler from the military than with an Islamist government in Egypt. That could be a green light for FDI flows.”

However, Samih Sawiris, Egyptian chairman and CEO of Switzerland-based Orascom Development Holding, says he does not plan to invest further in Egypt until there are changes to the legal system to protect investors. Sawiris has also called for the government to stop using force and intimidation in “the oppression of innocents.”

Hani Sabra, director of Middle East research at Eurasia Group, notes, however, that the government’s record on human rights won’t be a major factor in FDI decisions. “Egypt never had a glowing human rights record under [former president Hosni] Mubarak. Investors will look for progress on achieving economic goals.”

Needing help in developing its energy resources, the government says it will repay all debts to foreign energy companies by 2017. BP plans to invest up to $10 billion in Egypt’s natural gas sector over the next five years. The project has restarted after a three-year lapse. Shell and its joint venture partner, Badr El Din Petroleum, plan $400 million of investments.

“The fact that the government has shown its willingness to push through unpopular but much-needed economic reforms should support investor confidence and boost foreign capital inflows,” says William Jackson, economist at Capital Economics. “The poor business environment has held back foreign investment into the country, which has kept Egypt’s overall investment rate extremely low. Even before the Arab Spring, investment averaged around 18% of GDP, which is well below the emerging markets benchmark of 25%.”

There has been a flurry of recent investment announcements. Saudi Arabia’s Almarai dairy company and PepsiCo will invest $345 million in beverage ventures over the next five years. Coca-Cola will invest $500 million in Egypt over the next three years. This includes a $100 million juice plant in a joint venture with Saudi Arabia’s Aujan. Saudi Egyptian Construction increased its capital by $245 million, with Egypt contributing 100 acres of land in three cities for housing units. And Panasonic of Japan will invest $28 million to build a household appliances factory.

All together, this international corporate involvement bodes well for Egypt’s Investment ministry in reaching its stated FDI goals.